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When a bond is purchased interest (except for zero coupon bonds) and principle are paid. Most bonds insured by a third party a financial guaranty firm (monoline insurer) against any default. “Insured bonds have a higher credit ratings (A credit rating evaluates the credit worthiness of the underlying security or bond to pay back the loan to the lender, based upon the financial history, current assets and liabilities. “A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates.” Contrarily, the price of the bond will be lower, compared to a higher credit rating bond priced higher. 1) than bonds that are uninsured.” Among the largest financial guaranty firms: Ambac Financial Group, ACA Financial Guaranty Corporation and MBIA. These companies underwrite thousands of municipal issues every year and fortunately during the past number years received high credit ratings themselves. 2 Three top agencies provide independent credit ratings (including evaluating underwriters or financial guaranty firms) in the investment world: Moody’s, Standard and Poors (S&P’s) and Fitch IBCA: Range of risk: Low to default. A change in credit rating immediately affects the price of a bond (Higher or lower) and the public traded company stock (higher or lower). 3

Historically municipal bonds insured by financial guaranty firms rated Triple ‘A’ (low risk): Proven exceptionally safe investments, and nationally recognized or assured to pay interest and necessary on debt as scheduled, in case of default or financial difficulties arise by municipalities. 4 Also, until recently, financial guaranty firms have seen their earnings and share prices increased dramatically, because default rates have been very low. 12

In 2007, the financial crisis in many precise estate markets worsened as U.S homeowners defaulted on their mortgage payments. As a result, rating agencies drastically cut ratings on billions worth of mortgage — linked securities. Unfortunately, monoline insurance companies maybe exposed to paying billions of dollars in defaulted mortgage related securities. Also, a number of insured municipal bonds maybe at for risk for default, if the reduction in property tax revenue collections (related to the number of foreclosures in a municipality), Impacts upon paying timely interest on those municipal bonds and notable payments. Besides, many new homes are being valued lower attributed by the number of foreclosed homes, thus reduces property tax revenues. 9 Many economists predict in 2008, declines in homes sales and foreclosures will continue to increase, thus mortgage related insured securities increasingly become a financial trouble for guaranty financial firms. 13

In December 2007, MBIA reported guaranteed $30.6 billion of complex mortgage securities (“Included in the exposure is a pool of about $8.14 billion in CDOs (Collateralized debt obligation) backed by a combination of other CDO’s and mortgages, which some analysts consider the riskiest part of an investment portfolio.” 7) in total. The amount more than exceeds the entire net worth of the company, thus recognizable unfeasible to pay total amount insured in case of total default. Fitch IBCA said it may cut it’s “AA” rating on the insurer’s parent MBIA Inc. The company could avoid being downgraded if measures are taken to increase capital within four to six weeks. 5 Standard and Poor’s assigned a negative outlook for MBIA and Ambac Financial Group, may cut their ratings in the next two years. 6 Also, Standard and Poors slashed the credit rating bond insured ACA Financial Guaranty Corporation to a non-investment grade “CCC” (CCC rating suggest potential default. “Toronto – based Canadian Imperial Bank of Commerce said today it may have $2 billion of write-downs on U.S. subprime mortgage securities it insured through CA.” 10) form investment grade “A.” 9 “A downgrade of a top monoline insurer such as MBIA could trigger severe stress in credit markets and potentially mammoth losses on insured securities.” 8

Financially strapped monoline insurers may require an infusion of capital or bailout preventing credit rating downgrades, and securing sufficient amount of funds for insured defaults. Reported in December 2007, Merill Lynch & Company, and Bear Stearns Companies, where in talks to help bail out the financial strapped bond insurer ACA Financial Guaranty Corporation. “Contain Stearns declined to comment on any bailout speculation, through a spokesman said the investment bank was a small creditor of ACA and this has slight exposure to the bond insurer.” 9 Ambac Chief Executive Officer Robert J. Genader said: ‘ ‘ We are confident the performance of our insured portfolio and the measures being taken to expand Ambac’s capital position will be sufficient to return our outlook to stable.”10 Reported on December 10, 2007, Warburg Pincus, the global private equity firm, entered into a definitive agreement to invest one billion dollars into MBIA through direct assume of MBIA common stock and a backstop for a shareholder rights offering. “MBIA said the investment will, among other things, increase MBIA’s already substantial capital and claims paying resources.” Also, the company’s senior management assured investors their commitment to invest a total of two million dollars by purchasing company’s stock. Gary Dunton, MBIA’s Chairman and Chief Executive Officer said: “As we have stated previously, we have been evaluating various alternatives to further strengthen our capital position, particularly in light of the rating agencies’ pending reviews of residential mortgage — backed securities and collateralized debt obligations transactions that we have insured.” 11

The future financial stability regarding many financial guaranty firms remains uncertain. Certainly the short – term infusion of capital (bailout) for many financial guaranty firms insures their credit status and capability to pay interest and principle against any municipality and mortgage payment defaults. However, future mortgage foreclosures may further impair monoline insurers financial credibility and dependability insured bond holders expect in case of a default. Besides, shareholders of public traded financial guaranty companies concerned regarding their investment.

References:

1.) Credit rating – http://en.wikipedia.org/wiki/Credit_rating

2.) Insured Bond – http://www.investopedia.com/terms/i/insured_bond.asp

3.) What IS A Corporate Credit Rating? – http://www.investopedia.com/articles/03/102203.asp

4.) Types of Bonds – http://www.investinginbonds.com/learnmore.asp? catid=5&subcatid=26

5.) UPDATE 1- Fitch may cut MBIA’s rating on subprime exposure – http://www.reuters.com/article/marketsNews/idUKN2020994620071220? rpc=44

6.) MBIA says it has $30.6 bln exposure to CDO’s – http://news.yahoo.com/s/nm/20071220/bs_nm/mbia_cdos_dc_2

7.) MBIA Details CDO Exposure – http://biz.yahoo.com/ap/071220/mbia_mover.html? .v=3

8.) MBIA and Bear Stearns torpoedo rally hopes – http://news.yahoo.com/s/ft/20071220/bs_ft/fto122020071409589378

9.) Bond rating move could cost municipalities billions – http://www.post-gazette.com/pg/07354/843094-28.stm? cmpid=business.xml

10.) Amabac, MBIA Outlook Lowered by S&P, ACA Cut to CCC (update 6) – http://www.bloomberg.com/apps/news? pid=20601103&sid=a0IcyRVRTZxk

11.) Press Release – MBIA Increases Capital with $1 Billion Warburg Pincus Commitment – http://investor.mbia.com/phoenix.zhtml? c=88095&p=irol-newsArticle&ID=1085695&highlight=

12.) Credit crisis hits bond insurancer – http://www.cnn.com/2007/BUSINESS/12/20/us.mbia.ap/index.html? section=cnn_latest

13.) How bad will the 2007 housing market be? – http://realestate.msn.com/Buying/Article_busweek.aspx? cp-documentid=1699105

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